Financial benefits to carbon management

Materials World magazine
19 Dec 2018

Companies may be pressured into further action on carbon mitigation, or risk losing opportunities and weakening their financial standing. Khai Trung Le reports.

Asset devaluation and stock price depreciation are not the standard arguments in favour of action against carbon emissions and climate change, which have long centred on environmental benefits. But as financial interests are increasingly motivated to support green initiatives, there are stern warnings that organisations which do not take a proactive role in mitigating its footprint will find themselves as unpopular as their carbon output.

Although the most recent UN Intergovernmental Panel on Climate Change (IPCC) report, released in November 2018, advising that meaningful reversal of the impact of climate change may necessitate greater societal change and attitudes to growth, for many the most persuasive arguments remain financial. These have taken many forms, including a 2017 report from the London School of Economics that argued the economic co-benefits of reducing CO2 emissions already outweighed the cost of mitigation for big emitters, and the Church of Scotland expressing concern over its North Sea investments (see Materials World, July 2018, page 6), but few have been as brazen as a recent study from the University of Waterloo, Canada.

Physical risk to sensitive regions

The study, Sustainable portfolio management under climate change, published in the Journal of Sustainable Finance & Investment, predicts climate change will impact investment portfolios on two primary levels. Firstly, it will elevate weather-related physical risk to properties and infrastructure assets. This in turn will increase market risk to equity holdings with material business exposed in climate-sensitive regions.

Secondly, it will trigger more severe environmental regulations and higher emissions costs in an effort to control emissions, which is expected to create downturns for carbon-intensive industries. Investment will essentially be turned into a political risk affecting certain asset classes. This has been termed the investment carbon risk.

Mingyu Fang, PhD candidate at the Waterloo Department of Statistics & Actuarial Science, said, ‘Over the long term, companies from the carbon-intensive sectors that fail to take proper recognisable emissions abatements may be expected to experience fundamental devaluations in their stocks when the climate risk gets priced correctly by the market.

‘More specifically for the traditional energy sector, such devaluation will likely start from their oil reserves being stranded by stricter environmental regulations as part of a sustainable, global effort to mitigate the effects caused by climate change. These companies may find that large portions of the reserves are at risk of being unxploitable for potential economic gains.’

The study also analysed stock returns, and of 36 publically traded large emitters and related sectors in Europe and North America investigated by Fang on the ratification of major climate protocols, only nine were found to have displayed recognisable carbon pricing. The historic performance of emissions-heavy sectors, including energy, utilities and materials was compared with other industries and found that carbon-intensive sectors underperformed the market indices in Europe and North America, consistently ranking lowest.

Bang for your carbon buck

The Waterloo study was published days before the IPCC’s November 2018 report, which heralded the need for more dramatic efforts in combating climate change, stating that human-caused CO2 emissions need to fall by 45% from 2010 by 2030, and by 100% by 2050.

Jim Skea, Co-Chair of the IPCC Working Group III, said, ‘Limiting warming to 1.5˚C is possible within the laws of chemistry and physics, but doing so would require unprecedented changes.’ However, researchers from the Norwegian University of Science and Technology (NTNU) Industrial Ecology Programme claim these ‘unprecedented changes’ would require radical revisions to the way we look at economic growth.

Gibran Vita, an NTNU PhD candidate, said, ‘Society has to go to zero emissions pretty much overnight. Whether we like it or not, this challenge won’t be met without the corresponding changes in society. We need to start thinking, “Is the carbon footprint that comes from different economic activities actually worth it in terms of societal outcomes?” There is potential to live fulfilling lives with much less environmental impact.’

Much of the NTNU statement is focused on wider societal changes, and stressed that although wealthy countries that are already invested in infrastructure could make dramatic transitions easier, emerging countries are well placed to learn from the history of mistakes already made. Vita continued, ‘The science points to the fact that we need to rethink society as soon as we can. Emerging countries have the golden opportunity to leapfrog directly to a more sustainable vision of development – and escape ending up locked in to emitting carbon where no one gets a (well-being) bang for their (carbon) buck.’

Money where your mouth is

A collective of 415 global investors that together manage US$32tril issued a statement on 10 December calling on world leaders to further act on climate change, and warned that inaction would lead to significant risks for the global economy and financial systems. Made through the Investor Agenda lobbying group, the statement notes, ‘It is vital for our long-term planning and asset allocation decisions that governments work closely with investors to incorporate Paris-aligned climate scenarios into their policy frameworks’.

Similarly, Royal Dutch Shell (Shell) has agreed to link executive pay to carbon emissions targets in 2019, despite opposition from its chief executive, Ben van Beurden, who previously referred to setting hard targets as a ‘superfluous’ exercise that would subject the company to litigation. However, following ‘engagement with investors’, Shell has kowtowed to investors including the Church of England that have pushed for the company to embrace further cuts to its carbon footprint.

With a major energy entity taking public commitments, ahead of rivals BP and ExxonMobil, Tony Wirjanto, Professor of Finance at the Waterloo Department of Statistics and Actuary Science, stressed that it is in the best interest of companies to correctly price their carbon risk. He stated, ‘Companies have to take climate change into consideration to build an optimal and sustainable portfolio in the long run under the climate change risk.’